Tax Deduction Limitations

Tax Deduction Limitations of IRC Sec. 199A for Financial Professionals

Final regulations from the Internal Revenue Service (IRS) may impact the application of pass through income deductions for financial professionals. The Tax Cuts and Jobs Act (TCJA) is one of the most sweeping tax changes in 35 years. It provided major tax benefits for financial services businesses along with lower taxes for many individuals.

TCJA Changes

The TCJA reduced the maximum tax rate for regular corporations to 21% from 35%. A relevant pass through entity (RPE) like an “S” Corporation, Partnership, LLC, or Proprietorship can receive a 20% deduction under the new IRC Sec. 199A. However, there is a catch that not only affects potential business clients, it affects you as a financial professional.

IRC Section 1202(e)(3)(A) refers to “any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.” For these businesses there is a phase out of the 20% deduction. 

Limits to Sec. 199A Deduction

The Sec. 199A deduction is limited by several factors. First there is a prorata reduction of the 20% deduction for income between $157,000 and $207,000 for single filers. If married and filing jointly the corridor is between $315,000 and $415,000. Both are indexed for inflation. So above these amounts the deduction is gone.

Clarifying Regulations

The Internal Revenue Service issued final regulations on January 18th, 2019 giving more clarity to the application of the pass-through income deduction. The final regulations carve out architecture, engineering, and Life Insurance Agents from this list. For financial professionals the result is clear and positive for life insurance agents but not for planners, fee-based advisors, Representatives, and even retirement annuity professionals. So, good and bad news from the final regulations for financial professionals.

Potential for Clients

These rules still provide significant marketing opportunities for potential business clients. As many as 95% of small businesses fall under the Sec. 199A limits mentioned earlier*. Strategies like buy-sell funding, key person coverage, executive bonus plans, and split dollar plans can be more affordable for these businesses under the new tax act.

If you hypothetically had clients who own a small partnership, they likely understand they need a succession plan to protect their families in case either owner dies prematurely. They may not have had enough discretionary income in the past to afford funding a buy-sell agreement. If this hypothetical business is worth $1M, each owner is 48 years old, and each makes $200,000 from the business, the 199A deduction could save each of them $9,500 in income tax**. This savings could allow them the option to purchase of $500,000 coverage on each owner’s life, completing the buy sell agreement. Their policy could produce a cash value of $243,160 by age 65 in each owner’s policy***.  This strategy provides the protection they need without added financial stress and offers each owner a substantial retirement nest egg.

Opportunities like this hypothetical situation are the norm rather than the exception in many communities around the country. Keep in mind these changes in taxation when preparing strategies for your clients and for your financial services business.

My name is Kim Holland-Lyon, I have studied and worked in the financial planning industry for many years educating individuals through numerous programs to enhance their financial intelligence and practices, including tax planning. I am a SmartVestor investing pro. I hold several securities licenses and other certifications and designations to include Life, Health, Annuity, Long-Term Care, Identity Theft, Estate Planning and Real Estate. All of this knowledge enables me to offer comprehensive financial planning for my clients to help them prepare for financial independence and management of their investment portfolios.

I am happily married to Roger Lyon of Villard, MN and enjoy my life as a wife and business partner in the Dairy Farming Industry. We donate approximately 500 pounds of fruits and vegetables each harvest season to the local food shelves in our area and it is very important to me to support the men and women of the farm and ranching industry.

Whether you have long term financial goals or short term financial goals, please contact me directly at 561-302-5153 or coachkimmyelp@gmail.com.

Article Credit:  Bill Jackson J.D. CLU | March 2019